Chapter 4 - Factors influencing the demand for housing

Chapter 4 - Factors influencing the demand for housing

4.1
There are a number of factors which have driven up the demand for
housing, and in particular for home ownership, in recent years.

Higher incomes

4.2
As Australia has lifted its productivity, and benefited from the
higher prices for its commodity exports due to the 'resources boom', average
incomes and household wealth have increased.[1]
It is unsurprising that households have wanted to spend some of this increased
income and wealth on improving the quality of their housing. At the upper end
there has also been increased demand for second 'holiday' homes, particularly
in coastal regions.[2]
To the extent that supply responses are limited (see next chapter), this
increased demand leads to higher prices.[3]

4.3
For many couples, household incomes are higher because both
partners now work (as indicated by rising labour force participation rates).
However, as Professor Julian Disney notes:

By fuelling competitive bidding-up of house prices it has led
many couples into taking on excessive workloads to pay their mortgage.[4]

4.4
Incomes have increased at a similar pace across most income
quintiles in the past decade.[5]
But there are likely to be some groups whose capacity to save and bid for homes
has improved less than others. For example, around 300 000 people have accumulated
HECS/HELP debt, which may be an impediment to buying a home.[6]

Demographics

4.5
The average household size has decreased for a number of reasons,
such as later marriage, fewer children and increased incidence of separation
and divorce.[7]
This increases the demand for housing for a given population. Demographic
projections are for this to continue, with lone person households expected to
increase at a much faster rate than family and group households.[8]

4.6
Australia has relatively strong population growth for an advanced
economy. A large component of this reflects relatively high immigration
compared to comparable countries. Higher immigration rates have added to demand
for housing, especially as immigrants tend to be disproportionately young
adults.[9]
Immigrants have also tended to head for areas where housing is already short,
such as Sydney, rather than to country regions. This partly reflects a
perception of where the best job opportunities are located. It has a self-reinforcing
aspect as new arrivals prefer to locate in areas where friends or relatives
have already gone or where there are shops and cultural facilities catering to
people from their ethnic background.

4.7
An eminent demographer points out that:

About half the growth in households in Melbourne is attributable
to overseas migration. When you push out the 30-year projection, as you get
near the end of it, about 80 per cent of the growth is attributable to
migration...in Sydney, all the growth in households is attributable to overseas
migration.[10]

4.8
This has led some witnesses to suggest restricting immigration,
even of skilled workers, as a means of curbing rises in house prices:

One of the key drivers of the housing crisis, we believe, is the
continued rapid population growth in Australia, which is a continent of very
low carrying capacity, and most of the development is around the edges of the
continent...[we recommend] that we train our own skilled workers and that we
cease poaching skilled workers from other countries.[11]

4.9
In this context, the committee also notes concerns that in the
current environment of skill shortages in the construction industry, the net
impact of immigration is inflationary:

We do not have the trades to build the housing stock that we
need. Immigration into the country is fuelling demand at a much faster rate
than immigration is helping our industry build that extra demand.[12]

4.10
There are also alternative arguments:

I am all for increasing immigration....I think that, to support
infrastructure in this country with the landmass we have, we need a lot more
people to use those facilities.[13]

4.11
The Government has made it clear it sees substantial net economic
benefits from continued high rates of immigration:

The Australian labour market is the tightest it has been in a
generation, with skill and labour shortages pushing up labour costs and
contributing to inflationary pressures. Immigration will continue to be an
important contributor to labour supply, with skilled migration in particular
helping to address Australia's skill needs in the short-term while also
delivering fiscal benefits.[14]

4.12
The committee regards population growth policy as an important
issue, but one outside the terms of reference of this inquiry.

4.13
The relationship between the overall number of skilled migrant
workers and the number with particular skills in the construction industry is
discussed in more detail in chapter 5 (paragraphs 5.60–5.64).

High rents

4.14
The increase in rents in recent years has increased the desire
of many renters to buy a home instead of renting. However, having to pay higher
rents has reduced the ability of these households to save a deposit. The
net impact on the effective demand for house purchases is therefore ambiguous.

Lower interest rates

4.15
The decline in the standard home loan interest rates from the mid–1990s
to early 2002 increased the amount that households could borrow and so gave
them the ability to bid up house prices. For example, the repayments on a 30–year
mortgage of $100 000 at an interest rate of 14 per cent are $1185 per month.
When interest rates are instead 7 per cent, the same repayments can service a
loan of $178 000.

4.16
The main reason for the drop in housing loan interest rates had
been the lowering of the Reserve Bank's policy interest rate as a low inflation
environment has become established. But increased competition has also seen a
reduction in the margin between the policy interest rate and the housing loan
rate.

4.17
If this mechanism were the only driver of prices, then prices
would have fallen back again as interest rates have since risen. However, there
may be inertia in the system, or prices may be 'sticky', as vendors are
reluctant to accept low bids. This would imply that affordability will only be
restored by the gradual rise in incomes rather than a fall in nominal house prices.

4.18
Given that underlying inflation has recently risen above the
Reserve Bank's 2‑3 per cent medium-term target band, it could be argued
that aggregate demand in the economy has been allowed to grow faster than
aggregate supply. A loose fiscal and/or monetary policy is likely to result in
rises in asset prices, including house prices, as well as generalised
inflationary pressures.

4.19
When the Reserve Bank Governor was asked what the central bank
could do about housing affordability he replied:

the best thing that we can do is keep inflation rates
controlled, because if we do not do that then interest rates will end up much
higher than otherwise. I think the biggest problem for housing affordability is
that basically, particularly if you are a first home buyer, the level of house
prices is too high. The policies to address that are mainly not in our
preserve, except that, if we run monetary policy too loose, house prices tend
to inflate more than they need to and that would not be good.[15]

4.20
The committee received comment from one submitter who criticised
the Reserve Bank's approach to monetary policy. Mr Phil Williams highlighted in
his submission that the RBA's inflation target is set solely in terms of consumer
prices, not asset prices. The cost of land is not included in the CPI.
As a result, Mr Williams argued that the RBA's monetary policy failed to
respond to the sharp spike in house prices in 2002–2003.[16]
He claimed that the underlying cause of house price inflation is the conduct of
monetary policy which should aim for house price stability, not just the 2–3
per cent CPI band.[17]

4.21
The committee does note that the RBA has been vigilant in seeking
to restrain the CPI to within its target band. There have been several
increases in the official cash rate over the past three years which 'is helping
to produce a moderation in demand'.[18]

Greater credit availability

4.22
In addition to interest rates being lower, loans have become
easier to obtain. In the longer term this has been a welcome result of
financial deregulation. Non-bank lenders have increased the availability of
credit for housing, tapping into securitisation markets. Since deregulation,
the Australian housing finance market has developed a wide range of products
and credit is available to all potential borrowers who can afford the
repayments (Table 4.1).

4.23
In this brave new financial world, banks no longer 'ration'
credit only to customers with a long record of placing money in low-interest
deposit accounts with them. As the Reserve Bank's deputy governor noted:

...if you go back just 30 years it was very hard for households to
get access to finance. Basically, to get a housing loan you had to save for
years at the bank and then you had to plead with the bank to give you some
money and then they only gave you some of the money. You had to go to a finance
company, a building society or someone else and borrow at much higher rates to
get the rest of the money to buy a house...and if you were a woman you had no
chance.[19]

4.24
Looking back further, the increase in the availability of credit
is even starker.

Chart 4.1

Source: Battellino (2007).

4.25
However, there is evidence that recently credit standards have
been loosened excessively. This was been most noticeable in the United States
where the prevalence of 'sub-prime' loans is now causing serious problems in
financial markets. While Australian lenders have not gone as far as their
counterparts in the US, the Reserve Bank has referred to 'the general lowering
of credit standards that has occurred since the mid 1990s' and the Australian
Prudential Regulation Authority has referred to lenders having 'been willing to
move out the risk spectrum by loosening their credit standards'.[20]

4.26
Housing lenders are now much more likely to allow customers to
borrow amounts that require more than 30 per cent of income to service and will
lend a higher proportion of the value of a property.[21]
There is considerable variation among lenders in how much they will lend, as
noted by the Australian Prudential Regulation Authority: 'The most aggressive ADI
will typically be willing to lend more than twice as much as the most
conservative'.[22]

4.27
There are disadvantages in moving away from the old model where
banks required people to save a deposit with them before granting a loan. As Dr
Judith Yates commented: 'having a savings history is not a bad idea in that it
indicates that people do have the capacity to save'.[23]
Households unable to save regularly may struggle to meet loan repayments.

4.28
The greater availability of credit has fuelled the aspirations of
first home buyers. A Queensland developer gave this example:

When we first started developing land out there [Ipswich], in
1992, we noticed that people would buy a block of land and spend probably the
next 12 months building their house. They would spend every weekend out in the
front yard landscaping, doing all those things that they could not afford to do
when they first built the house. It probably took them almost two years to come
up with a house in the form that they actually wanted. Now we do not see any of
that. Now we see people shifting into a house with everything done up-front—swimming
pool, landscaping, everything. My point is: I think people want everything
straightaway these days.[24]

4.29
As lenders moved from rationing credit to marketing it, some
households were offered larger amounts of credit than they could readily repay:

Deregulation of the financial institutions in the eighties had a
significant impact on low-income people. Not only do those people sign up for
things they cannot afford but also they often do not understand the paperwork
they are signing.[25]

4.30
A similar view was put by John Symond of Aussie Home Loans:

money has been too free. Instead of looking at getting their
ultimate home step-by-step, young people expect and want a new home with all
the mod cons. They go off to a department store and borrow $20,000 for a plasma
TV, new lounges and everything else in the belief that it is interest-free and
the latest and the greatest. They then find out that they have been stung with
a 28 per cent interest rate. So clearly credit tightening would be a good
thing.[26]

4.31
Regretting some of the excesses associated with financial
deregulation might be regarded as wishing the stable door had been shut before
the horse had bolted. But the committee did hear some suggestions for some mild
forms of regulation to address these concerns:

Options for consideration may include mandatory minimum credit
checks, minimum loan-to-value ratios for property purchases, restrictions on
advertising targeting persons with a poor credit history, or public disclosure
of the level of credit risk held or on-sold by lending institutions.[27]

Speculative demand

4.32
In addition to the demand from people wanting a house in which to
live, there is a speculative element to the demand for housing. As one witness
put it, 'houses are being valued as speculative assets, not as homes for
Australians anymore'.[28]
(See the discussion in Chapter 2 on 'changing aspirations').

4.33
As well as encouraging home ownership, this attitude has led many
households to borrow to purchase a second investment property.[29]
Investors now account for about a third of new home loans. The Reserve Bank
(2003, p. 48) has referred to the role of unregulated property investment
seminars in promoting the purchase of investment properties.

4.34
Except for the brief period of 'irrational exuberance' about hi‑tech
stocks around 2000, Australians have generally regarded property as a better
investment destination than equities, although they are less attracted to it
now than in the 1980s.

4.35
There is a self-reinforcing aspect to speculative booms:

Related to this boom period is the self-generating nature of
house price rises. Most finance for housing arises from the high price already
of existing housing, because people upgrading build on the increased value of
their housing, and investors are then drawn in by rising prices. So you have a
self-generating effect until they hit something like much higher interest rates
or a recession or something.[30]

Chart 4.2

Source: Reserve Bank (2003, p.
41)

Taxation influences

4.36
This speculative demand for housing may be encouraged by some
aspects of the taxation system, which makes investing in housing (and sometimes
other assets yielding capital gains) more attractive than alternative
investments. A blunt assessment is provided by Professor Julian Disney:

...a major cause of our problems is that we have excessive
exemptions for owner-occupiers from capital gains tax, land tax and the pension
assets test. They are so generous that they have driven up housing prices. They
have ended up being not in favour of homeownership; they are in favour of
current homeowners but they are not in favour of homeownership.[31]

4.37
In similar vein, the economics journalist Ross Gittins has
commented:

Do you see what the special tax-free status of housing does? By
pushing up the price of homes it makes it that much harder to attain the state
of being a home owner, but makes the benefits of home ownership even greater if
you manage to make it. The jackpot's bigger, but harder to win. And a system
that is biased in favour of owner-occupiers is a system that is biased against
renters. That's unfair to people who spend all their lives as renters, as well
as making it harder for would-be home owners to make the leap.[32]

4.38
Significant tax concessions are currently provided for housing.
It is not easy to find hard data on the costs of most of these concessions[33],
but the secretariat has put together in Table 4.2 some approximate numbers from
the sources indicated, based on the assumptions listed. In addition to the tax
expenditures listed, the exemption of owner-occupied housing from the asset
test for the age pension costs around $10 billion.[34]

4.39
The combined total of capital gains tax arrangements, land tax
exemption and negative gearing arrangements is estimated to be in the order of
$50 billion per year. That reflects against the $1½ billion in the
Commonwealth–State Housing Agreement and the $1 billion spread over four to
five years proposed for the new National Rental Affordability Scheme and the
Housing Affordability Fund. These tax concessions also mean that the overall
support to wealthy homeowners is greater than that to low income renters.[35]

4.40
The tax treatment of housing in Australia is compared with that
in comparable countries in the above table.

Recommendation 4.1

4.41
In the interests of more informed discussion of arrangements to
encourage affordable housing, the Treasury be asked to publish current
estimates of various taxation and related measures affecting the housing
market.

Discount on capital gains on
investor housing

4.42
Capital gains on investor housing held for over a year are taxed
at half the marginal tax rate applied to other income.[41]
A common argument for this discount is that it also applies to holdings of
shares.[42]
Some would contend that the logic of not discriminating between different types
of income would mean that all capital gains should be taxed at the same rate as
other income. (In some tax regimes, capital gains are regarded as 'unearned
income' and taxed at a higher rate than other income.) The current
arrangements do not apply to alternative investments, such as bank deposits
(and education and training), which generate income that is not in the form of
capital gains.

4.43
A number of witnesses argued that capital gains should be taxed
like other income. Apart from fairness concerns, it was argued that the concession
encourages investors to focus on investment in that type of housing where
capital gains are expected to be largest and this may be more expensive rather
than affordable housing:

...we should not have the discount on capital gains tax, because
it is crucial that we do not encourage investment to go where the capital gain
is the greatest. We need it to go to the bottom end.[43]

4.44
Another suggestion was that the concession be more focused:

Australians would be better served if the incentives were based
entirely on newly constructed houses rather than established houses so it led
to an increase in supply.[44]

4.45
In contrast, the construction industry argues that the tax rate
on capital gains should be lowered further:

...governments need to introduce a stepped-rate capital gains tax
where after, say, 10 years there is no capital gains tax applicable. This will
mean you will get investment into the rental market.[45]

Capital gains tax exemption for
owner-occupied housing

4.46
Capital gains on owner-occupied housing (the 'family home') are
exempt from income tax. This is another aspect of the taxation system which
favours housing as an asset class and increases demand for it.

4.47
Master Builders Australia argue that the exemption should be
retained, on the grounds that:

There is no empirical evidence to support the proposition that
the tax exempt status of home ownership undermines the equity or efficiency of
the tax system.[46]

...the tax breaks afforded to housing—for example, the absence of
capital gains tax for owner-occupied housing...just simply tend to feed in to
higher prices for housing.[47]

4.49
The exemption may also lead to households demanding larger homes
than they require at the time for accommodation, to increase their prospective
capital gains:

Owner-occupiers were encouraged to over-invest in housing
producing the so-called 'McMansions' in the outer suburbs. This was, in part, a
logical response to the fact that capital gains are not paid on the family
home. The family home was thus seen by middle income households as an
opportunity to maximise their savings.[48]

4.50
Another fault with this tax concession is its regressive nature:

...the capital gains tax exemption for owner-occupied housing is
vastly regressive in a social sense, with nearly all the gain from that
exemption going to high-income households.[49]

Land tax exemption for
owner-occupied housing

4.51
All states, and the ACT, impose land taxes but exempt almost all
owner‑occupied housing (Table 7.6). This impacts on what in principle
would be an efficient and equitable tax and can encourage some people to hold
wealth in the form of housing in excess of their requirements for
accommodation.[50]

4.52
Shelter WA recommends capping this exemption to a level 10 per
cent above the median house price for the region.[51]

4.53
A problem in taxing the land value of owner-occupied housing is
that asset‑rich but income-poor households, such as retirees, may need to
incur debt to pay it. This is easier to do now that 'reverse mortgages' are
more readily available, but older households are likely to be wary of
increasing their debt. Professor Disney suggests addressing this problem by
making the land tax at least partially deferrable until sale.[52]

Negative gearing

4.54
'Negative gearing' refers to allowing investors to deduct losses
on rental property from their other income (not just other property income) and
so lower their tax liabilities. In aggregate, landlords received gross rental
income of $19 billion in 2005–06, from which they were allowed to deduct $14 billion
in interest, $1 billion in capital works deductions and $9 billion of other
deductions (including letting agents' fees, body corporate levies and council
rates), giving an overall 'loss' of $5 billion which they could offset against
other income.[53]

4.55
Included among the deductions is a depreciation allowance of 2½
per cent on new buildings. This had been introduced at 4 per cent in 1985 when
the scope of negative gearing was reduced by quarantining the interest cost
offset to rental income.[54]
The rate was lowered to 2½ per cent in 1987 when the quarantining was removed
and full negative gearing restored. It could be argued that houses are an
appreciating rather than depreciating asset, or that 2½ per cent overstates any
physical depreciation (ie that the average house will last more than forty
years).

4.56
Negative gearing is criticised on equity grounds:

We have argued that it is iniquitous. It is not spread fairly
and it really represents one of the starkest contrasts in the Australian
taxation system.[55]

4.57
This leads to suggestions to cap it.

...there should be caps. There should not be unlimited access.
Millionaires and billionaires should not be able to access it, and you should
not be able to access it on your 20th investment property. There should be
limits to it.[56]

4.58
Master Builders Australia defend negative gearing as 'part of a
modern tax system'.[57]
Table 4.3 shows that tax systems in a number of modern economies do not allow,
or restrict, negative gearing.

4.59
The Real Estate Institute of Tasmania claimed that 60 per cent of
those using negative gearing 'are your mum and dad investors—normal
Australians—not the rich and wealthy'.[58]
While investors owning rental properties may be 'normal', they may also be more
affluent than the average taxpayer.

4.60
A number of witnesses point out, correctly, that negative gearing
also applies to other investments such as purchases of shares.[59]
However negative gearing seems to be used a lot more for housing than for
investment in other assets, with some recent estimates suggesting that a third
of investors in housing claim they are making losses. In many cases, when the
rental property is initially bought, the investor expects to make such a loss
but hopes that (concessionally taxed) capital gains will mean the undertaking becomes
profitable. As noted above, in Australia housing investors routinely make an
aggregate loss, while in other countries they generally make an aggregate
profit.[60]

4.61
The most common argument by supporters of negative gearing (and
capital gains tax concessions) is that it increases the supply of rental
accommodation and keeps rents lower than they otherwise might be.[61]
FaHCSIA stated that 'the taxation provision for negative gearing has
demonstrably increased the amount of rental housing that is available in the
broader market', but under later questioning, acknowledged that 'we do not have
any information from our own sources' to support this and made references to
work by the Australian Housing and Urban Research Institute.[62]

4.62
It does seem to be the case that rental yields (ie rent as a
proportion of the property price) on their own could be unattractive without
the tax advantages. A common rule of thumb in the Australian real estate market
is that a property that costs X thousand dollars will rent for about X dollars
per week. This implies a gross yield of about 5 per cent. After deducting
expenses such as maintenance, letting agents' fees and so on, net yields are
lower, currently around 3 per cent. This is well below interest rates being
paid by banks.

4.63
But a further reason advanced as to why these yields are low is
that the tax advantages given to housing have led to house prices being bid up.
On this argument, without these tax breaks, house prices would be lower, making
rental yields attractive to investors without the tax breaks being required.

4.64
As noted above, negative gearing was restricted in July 1985 and
restored in October 1987. Rents rose around the time it was restricted and its
restoration was followed by an increase in the supply of rental housing.
However, some argue this may have had more to do with the global stockmarket boom
and crash occurring at the same times, initially attracting and then scaring
investors away from shares – the main alternative investment asset to rental
housing.[63]

4.65
Negative gearing is also seen as advantaging investors over owner-occupiers.
One witness claimed it 'amounts in essence to much cheaper finance for
investors versus home buyers'.[64]

4.66
Even if negative gearing encourages investment in rental
property, many witnesses agreed 'the funds that go into negative gearing
housing for rental do not go to modest or low-income rental'.[65]
Two examples of this argument are:

...there is a major need...for some changes in our taxation system
that are going to support investment in long-term, low-cost rental
accommodation. ...We have seen negative gearing have a positive impact on the
willingness of people to invest in rental property as part of their investment
profile and strategy. But that is very selective and it is not long term. If we
are to deal with the rental accommodation side of housing affordability, we are
going to need to see superannuation funds, infrastructure funds and the like
being prepared to take a long-term view of developing and holding that
accommodation, to provide low-cost rental alternatives for our society.[66]

At the moment the only good that comes out of the use of
negative gearing is the creation of rental property but, unfortunately, very
little of it is at an affordable level.[67]

4.67
To the extent that negative gearing changes the tenure
arrangements of some housing, it is not regarded as particularly beneficial by
some:

...with a given block of housing, if an investor simply turns a
house over from owner-occupation to investment, that on the face of it means
there is more housing for renting, but they are obviously displacing one
household net from owner-occupation to renting. On the face of it, investment
in housing simply does not assist the renting situation.[68]

4.68
There are differing views about whether negative gearing leads to
construction of new housing or a bidding up of the prices of existing homes.
The Real Estate Institute of Australia argues:

Negative gearing as it is certainly encourages the building of
new property. Given that a major component in the tax offset—or write-down, if
you like—of negative gearing comes from the depreciation component, that
component is obviously a lot higher and a lot more attractive for new
properties. So a lot of money from investors using negative gearing as it
stands actually goes into new property.[69]

4.69
Professor Sorensen by contrast believes:

...the tax breaks afforded to housing—for example...negative gearing
for rental property...just simply tend to feed in to higher prices for housing...We
would have lower rentals combined with better returns for owners of rental
accommodation, were negative gearing to be abolished.[70]

4.70
This has led to some suggestions to modify it in ways that would
encourage construction of new and affordable housing. Mr Pollard suggests:

negative gearing be applied only in the case where investors buy
new houses and that it not apply to the buying of established houses. The
effects of this would be that investor interest in established houses would
fall significantly and so we could expect that prices in future would rise much
less than prices of housing generally otherwise, because the vast majority of
investor finance is used on established houses.[71]

4.71
National Shelter suggests:

to taper it to ensure that you can only maximise the level of
investment on it if you are building affordable housing.[72]

4.72
Along similar lines, Professor Burke suggests restructuring it:

...in a way which encourages greater investment in new supply and
lesser investment in existing stock, which only puts investors in competition
with first home buyers. ...Instead of having 100 per cent allowable for all
expenses, you have a higher deductibility—we recommend up to 125 per cent—for
investment in new construction and the purchase of the new rental property. It
reduces to only 75 per cent deductibility for investment in an established
property. That 125 per cent deduction only applies for a benchmark
affordability property—in other words one that is probably around $300,000,
which could be indexed annually. But then the 125 per cent reduces as prices go
up. So over some cut-off point like $500,000 or $600,000 you are back to the 75
per cent.[73]

4.73
Only a few submissions wanted to abolish negative gearing totally.[74]
But there were other suggestions to restrict or quarantine it:

The loss would be available in future years as the rent income exceeded
the expenses, but in the early years it can't be used to reduce overall taxable
income. This would have an effect without being a massive change.[75]

4.74
The attractiveness of negative gearing would be greatly
diminished if the tax discount on capital gains on investor rental housing was
removed.

Recommendation 4.2

The committee recommends that Australia's Future Tax System Review
Panel consider the implications for housing affordability, as well as the
overall fairness of the tax system, of the: